Brexit – EU-UK Trade options

The resignation of Sir Ivan Rogers highlights the uncertainties likely to follow the UK’s invocation of Article 50 - and Mrs May’s Lancaster House speech (17 January) the possibilities for a new UK-EU trade deal. Whilst any eventual outcome will be unique, there are basically seven broad options for the negotiators to pursue.

As the UK Permanent Representative said, “free trade does not just happen”. Trade is under greater pressure now than for many years. Trade is a key driver for growth and jobs, and increasingly depends on compatible regulatory and technical standards, rather than on political bargaining. Yet voters are increasingly protectionist as witnessed by the Brexit debate on reducing migration and outside legal jurisdiction, e.g. the European Court of Justice (ECJ).

For the UK, there are two urgent priorities: first is to reach agreement with the EU as to their future mutual trading relationship. Third countries will need to take that into account before completing any new trade deals with the UK, not least as some 85% of the UK’s current trade is with EU Member States, countries covered by an existing trade agreement with the EU, or those with such an agreement under consideration.

The second priority for the UK is to establish its own WTO schedules (currently it is party to the EU’s) to determine its basic fall-back tariffs. However, this too will need negotiating, potentially with each WTO Member.

The first option for the UK and EU is for the UK to remain part of the Single Market (SEM). This would be the most business friendly, soft ‘Brexit’, route, with least risk of extra trading costs. The UK would effectively revert to its former Membership of ‘EFTA’, now the European Economic Area (EEA). The UK could still negotiate separate trade deals; nor does the EEA cover agriculture or fish.

The Scottish Government backs this solution, but Mrs May is already ruling it out. This may lead to a constitutional clash within the UK, not least as remaining part of the SEM, avoiding a ‘hard border’, would also support the Irish ‘Good Friday Agreement’. That was overwhelmingly endorsed by voters in both parts of Ireland: should the electorate of part of its next-door island now have the right to override that? This 1998 Agreement, which set up a power-sharing Government in N. Ireland, was based on the assumption that both parts of Ireland remain in the EU and within the Single Market, allowing border posts to disappear.

However freedom of movement and the role of the ECJ are also central to the SEM, of greater concern to many. The UK would still have to make a significant financial contribution to the EU, yet would lose its voice in Brussels and any say in the future development of the SEM. “No taxation without Representation” was a key rallying cry for Britain’s American colonists in the 1770s.

For business a major drawback would be the need to apply complex “Rules of Origin” (ROO) for exports, which the OECD estimates could add up to 24% in extra costs either way. A major problem where components originate across several countries (such as in aerospace or even televisions), as seen with the growth of Global Supply and Value Chains which operate within the EU as well. This could lead to loss of business, or moves to resource from elsewhere. Although less key for oil and fish, many EEA companies prefer extra duties to extra bureaucracy.

The second, Swiss, option might be close to what emerges, but is nobody’s first choice. After the Swiss 1992 vote against joining the EEA a whole series of agreements followed that do not quite replicate the EEA. Neither the EU nor the UK would want to repeat that.

The third option, for the UK to remain in the Customs Union (CU), or to negotiate a partial customs union like Turkey, is important. Formed in 1968 the CU was the original “Common Market”, with no internal tariffs. It includes the EU28 and small states like Monaco - but not the EEA.

The key advantages for business would be that common external tariffs would apply and extra ROO export costs avoided. The Good Friday Agreement would be safeguarded: despite no free movement of people, Britain and Ireland already share a ‘Common Travel Area’.

A partial CU is possible, but the UK would have a problem in that it could not negotiate trade deals ahead of the EU. So far Turkey has not been that successful in playing catch-up where the EU has already negotiated these. In one case, the third country in question (Mexico) refused to extend its concessions to Turkey, exporting goods instead via nearby EU countries. The CU with Turkey is now being updated as it does not include agriculture, services or public procurement, nor does it cover consumer, social or environmental concerns.

With much ingenuity a fourth option – a Free Trade Area (FTA) - could be based on EU agreements with the Ukraine, Georgia and Moldova, and as proposed for Morocco and Tunisia. There would be no EU membership, no customs union, or free movement – but these are agreements designed to help neighbouring countries catch up: hardly appropriate for a major OECD economy. For anything more substantial, bigger UK concessions would have to follow.

Fifth is the “Canada plus” option: yet following the CETA example is only really appropriate where the regulatory regimes are far from aligned, such as with the US (17% of UK trade) or China (4%): hardly relevant for Europe (44%).

The sixth option is reverting to basic WTO rules and tariffs, or hard ‘Brexit’, seen by many as the default scenario, not a positive option. The UK first needs to establish its WTO schedules, but these would still add tariffs to most imports and exports, ranging from 4% to much higher levels for food and agricultural products. Following that, as Sir Ivan inferred, specific trade deals can take years to negotiate. As Mrs May is looking for a full FTA with the EU27, this would necessitate a transitional arrangement if the WTO option were not to operate in the intervening period.

Finally, any failure to agree, or a walk-out wrapped in the flag, would in effect lead to an unseemly dash back to the WTO option.

About the author:

Jonathan Peel

Member of the Employers' Group,

Business and Trade Consultant